A derivative security is a financial instrument having dependence on the value of the other variables. The other variable may be any commodity or stocks. The word derivative comes from the word derive. It is quite clear that the one commodity is a base of a financial instrument having some value, and the value is based upon the underlying commodity which we took as a derivative basis.
Derivative securities are traded in Over The Counter (OTC) as well as in formal stock exchanges. Wherever the derivatives are being traded, the places collectively are known as “derivative market”. However there is some difference in transactions and procedural commitments while trading in OTC and structured stock exchange. Derivative market is a name of some place where two unrelated parties enter in a contract having distinguished beliefs about the market motions. For instance, one party believes the market will go up while the other thinks that the market will go bearish in the upcoming duration. Well, it is difficult to map out the correct anticipation prior to the happening of actual event. In a nutshell, investors are lean to hedge the potential risk due to market turn around in a particular position held by them.
Derivatives securities are widely used to hedge the associated risk for future time period. The risk can be hedged or covered through the derivation of the underlying asset or other financial instrument to the derivative contract. However these securities are now being traded by the speculators as well in order to get benefit of the expected spread. This is not about to hedge the risk but is exercised to earn profit as we do through the means of businesses.
With respect to the securities’ law (2nd amendment), Act of 1999, derivatives have been added up in the definition of the securities. Prior to that, these were not formalized securities rather just informal contracts transacted in over the counter markets in personal capacity. A derivative has two essentials according to the definition provided by Securities and Exchange Commission of Pakistan. These essentials include a security and a contract. The security is the same which has been elaborated in above section.
Modern derivates are traded on Gold, Silver, Currency, Wheat, Rice, Cotton, Crude Oil, and other agricultural and financial instruments. There are four types of derivative securities with a little structural difference present. The types include Futures, Forwards, Options, and Swaps. Out of these four, only forward is not traded in formal stock exchange because it is a bit informal. Apart from this, there is no difference between the operative procedure of future and forward contract. Forward contract is executed in over the counter market in the personal capacity. There is no back up offered by Securities and Exchange Commission of Pakistan (SECP) in case of breach of the contract by any of the parties. However, several remedial measures may be taken in order to stay out of risk of contract breaching. Following is a list of organizations working in Pakistan which offer trading in the derivatives:
- Pakistan Mercantile Exchange (PMEX)
- IGI Finex Securities
- KASB Securities
- JS Global Capital Limited
- Elixir Securities Pakistan (Private) Limited
- Darson Securities (Pvt.) Limited
- Falcon Commodities (Private) Limited
- Fortune Securities Limited
- ADAM Securities Pvt Ltd
- BMA Capital Management Limited
- Invest Capital Market Limited
- Crosby Markets Private Limited
However derivatives can be traded in international virtual forums as well. Along with this, local investors can move towards international markets such as New York Stock Exchange (NYSE), Osaka Mercantile Exchange (OMEX), Tokyo Commodity Exchange (TCEX), and etc.by